Change is Coming for Foreign Invested Companies

The new Chinese Foreign Investment Law (the “FIL”), promulgated on March 15, 2019, is set to become effective on January 1st 2020. Under the FIL, foreign investors and foreign investments have the right to “national treatment,” which means identical treatment to that of Chinese domestic investors and native investments, with some exceptions for key industries stipulated on the “negative list”. The FIL would protect the legal rights and interests (including in particular the intellectual property) of foreign-invested enterprises, and further simplify the registration and administration process for foreign investment.

One of the most significant changes introduced by the FIL is the abolishment of the Laws on Sino-Foreign Equity Joint Ventures (“EJV”), Wholly Foreign-owned Enterprises (“WFOE”) and Sino-Foreign Cooperative Joint Ventures (“CJV”), which have been the cornerstones for setting up foreign invested companies up until now. As of January 1st, 2020, these special entities shall no longer be available, and the PRC Company Law (the “Company Law”) will be universally applicable to all types of companies established in China, including those just mentioned. There is a grace period for shifting over to compliance with the Company Law, however, and companies established under those three laws before January 1st 2020 may still keep their original organization forms until December 31st 2025.

If parties to a new corporate formation completed the process before May 15, 2019, then the current legal framework shall apply to the new entity. Alternatively, if the parties agree to postpone formation until January 1st, 2020, it is then no longer necessary to follow the former legal framework, and the PRC Company Law will govern. That is, the parties will not be required to sign a joint venture contract, but may still sign a shareholders agreement. Of course, even before the new FIL takes effect, both current and potential foreign investors may begin the process of adjusting their administrative structures or establishing a new foreign-investment enterprise under the Chinese Company Law.

The Company Law considers granting more autonomous rights among shareholders to oversee the company. In fact, other than some mandatory stipulations, shareholders essentially have the right to design whatever management structure they want to through their articles of association.

Some fundamental changes and potential changes include the following, with a focus on EJVs:

  1. Highest authority

Under the current laws for Sino-foreign equity joint venture enterprises, the board of directors is the supreme decision-making body. That is, no shareholders meeting is required by law, and directors are generally considered to be shareholder representatives. Under the Company Law, the shareholders meeting is the supreme authority of the enterprise. After the implementation of the FIL, all foreign invested enterprises will be required to adjust to having the shareholders meeting as the supreme decision-making body which, in turn, chooses the board of directors. The board of directors is responsible to the shareholders meeting, and only has executive functions and certain other decision-making powers.

This new role for shareholders is a mandatory stipulation under the Company Law. This might cause some complications, though. For example, when each party holds 50% equity, they likely expect equal voting rights. However, under the Company law, shareholders’ voting rights can be different from their equity ratios. It is possible that one party might cite this provision in the Company Law and angle for more voting rights in order to gain control of the company.

  1. Directors

Under the current EJV law, boards of directors may be appointed by respective shareholders directly through the agreement among the shareholders. However, maybe the shareholders agree that “shareholder A appoints 2 directors and shareholder B appoints 3 directors” without specific names. Under such circumstances, shareholder B cannot refuse the specific person shareholder A appoints, and vice versa.

Under the Company Law, directors will be elected by a shareholders meeting. So, if some party objects to a director proposed by another party, they can overcome a resolution of the board of shareholders (the election of this director) if they gather over 50% of shareholder votes. In other words, this method provides shareholders with the opportunity to refuse a director’s position.

In practice, imagine that Company A is established under the EJV Law, for example. Five directors are to be appointed by represented shareholders, a (vice) chairman shall be determined by shareholders or selected by directors meeting, and one party appoints the chairman, while the other party appoints vice chairman.

Under the Company Law, this would function differently. Five directors would be elected at the shareholders meeting, while the vice chairman may be selected according to rules stipulated in the articles of association, for example by shareholders’ appointment, or selected by the chairman or board of directors, etc.

  1. Legal Representative and Chairman of the Board

Currently, the chairman of the board of an EJV must statutorily be the legal representative of the company. Under the Company Law, however, the legal representative role can be assumed by the general manager. If one party does not want somebody from the other party or parties to hold the position of legal representative, it is therefore possible to negotiate that the general manager, as appointed by the board of directors, take on the role of legal representative.

  1. Senior Officers

According to both the current EJV law and the Company Law, parties have the right to nominate some senior officers to be appointed by the board of directors. General managers can ordinarily appoint and dismiss other senior officers.

One subtle upcoming change is that, under the current EJV structure, it is not possible for the general manager or deputy general managers to hold such positions in other organizations, nor shall they join in the activities of organizations that might be in competition with their EJV. Under the Company Law, however, there is no such restriction.

  1. Reserved matters

The Company Law provides different stipulations from the current framework regarding matters reserved for directors as well. Perhaps the most important difference is that statutorily reserved matters will be decided by a shareholders meeting, with a 2/3 voting majority being enough to pass a resolution, as opposed to requiring unanimous approval of a board of directors. Such matters include amendments to articles of association, increase or decrease in registered capital, dissolution or change in company form, mergers, etc.

Taking the above into account, it seems that the Company Law provides a high degree of autonomy in certain aspects of corporate operations. Compared to the mandatory stipulations under the various laws the FIL is meant to abolish, under the Company Law, companies will have more discretion related to the shareholders meeting, as well as the right to make their own procedural rules, profit assignment rules, etc.